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6 Critical Financial Miscalculations I’ve Made – That You May Be Making as Well

by Darwin on November 6, 2011

You might think I’m a hypocrite for what I’m about to admit (since I blog about personal finance), but this is reality. In the past, I’ve made some wildly erroneous assumptions about our future ranging from how much we’d be making and spending each year to how our investments would perform. Many of these misconceptions are still somewhat ingrained in my thinking because I took them for granted and it was “conventional wisdom” pounded into our heads for years, and I need to constantly reinforce that THEY ARE NOT TRUE – at least not anymore. It’s a new world that many Americans haven’t yet accepted but after reading both of Thomas Friedman’s economic reality books That Used to Be Us and The World Is Flat you will. We’ve based our lives and major spending decisions like homes, cars and lifestyle on faulty assumptions. On the plus side, we always spend less than we make and I’ve been putting away money for the kids’ college accounts for years, retirement, and we enjoy plenty of great life experiences. However, many people with more discipline than us would have amassed a small fortune by now, while we let a lot of money slip away on questionable spending. Here are some critical mistakes in financial assumptions I’ve made over the years and I’d interested in hearing about whether you agree:

My Salary/Compensation Assumptions Were Shit – Earlier in my career I was a perennial high performer. When I hadn’t really factored in was that I was a workaholic and many of my fellow peers at the starting level were boneheads so it didn’t take that much to stand out. Initially, I based my future compensation projections on the past few years. Sounds reasonable, right? I had been getting 5-6% raises annually, a promotion here and promotion there, and while I realized I’d only be able to get a promotion 2-3 more times in my life before topping out, there were lateral moves and annual raises along the way which would reasonably give me at least 4% raises on average forever. Well, that’s all gone to shit. See, because we have zero percent fed funds rate and a horrific job market, companies aren’t inclined to pay their employees much more each year at all. They can claim inflation is low and honestly, they’re not too worried about losing employees because workers are afraid to leave! I’m at a point in my career now where I’m not even sure I want to be at the next level right now, and with the level I’m at now, in order to get there, there are quite a few high performers, making it tougher and tougher to be in the top 10%, let alone top quartile each year. So, we’re living in a new future of 1-3% salary increases as far as the eye can see. To add insult to injury, there’s inflation (next bullet) and my benefits are costing way more than the cost of inflation each year (see my outrageous health care premium increase for 2012). So, in terms of present dollars, my salary will decline every year forever. This is the new reality that I don’t think most people have yet accepted. If you DO need to get salary increases that are actually meaningful each year, you’re probably going to need to jump around a bit rather than staying with the same company. The absolute BEST free service out there for seeking 6-Figure Jobs only is TheLadders – sign up and you’ll get job openings emailed to you which are honed to your industry, focus and salary range.

Assume a 2-3% Inflation (that’s what it’s always been!) – Using the contrived government benchmark inflation indices, inflation continues to run pretty low. Low enough that over the past few years, Social Security recipients didn’t even see an increase in their COLA multiple years in a row. Fast forward to this year, and inflation shows some gains, but averaged over the past several years, we’d be led to believe it’s been quite low. Well, my personal rate of inflation is off the charts, so the government numbers are useless. My healthcare costs are skyrocketing each year, I’m trying to keep up with 7% college tuition increases each year for the college savings plans and virtually all my other costs are too – and our family keeps expanding! Some of this is self-imposed of course, but the reality is, inflation is nowhere near 3% for our family. When I look at our annual spending and even cut out “non-recurring expenses” like Disney or whatever, our Family Rate of Inflation is probably more like 6-8% per year, not 2-3%.

When I Make More Money, I’ll Have More Than Enough to Save More Later – This is one of the most common guises so many young people start out with. Get it out of your head because it’s not true, unless you make it so. And we haven’t. Due to every other bullet in this post, while yes, I do continue to make more money each year, our expenses tend to keep up with, or even exceed our income gains. If you’ve been light on your retirement savings or plan on saving at a much faster rate for your kids’ college when they turn 8 or 9, you’re screwed. You’re already behind the 8-ball and you’ve gotta get saving now, because life doesn’t get any cheaper as you and your children age (if you have kids). Trust me, you won’t be making so much more in 5 years or 10 years that you’ll have all this excess disposable income to divert to those accounts.

Expect Stocks to Gain 9-10% Annually (give or take a little volatility) – This has become a stale headline following the “lost decade” of stock investing, but one can’t ignore just how blatantly let-down equity investors are of late. I based a lot of long-term retirement plan assumptions on an average annual return of 8% thinking I was being conservative. Turns out that was wildly optimistic. With the fed wiping out income opportunities, I’ve had little choice but to retain equities as a primary asset class for my investments but I did make it a point to diversify into real estate investing this year by essentially shifting $50,000 out of stocks and into that new asset class. I actually anticipate higher returns there with less volatility. What are your new assumptions for total returns in stocks? Mine is more like 6% annually over the next 20 years.

Babies Are Expensive (and growing kids aren’t?) – I’d always heard about how expensive babies were. You know, all those diapers, baby food, doctors’ visits and baby clothes. The costs seemed crazy for such a little creature. That became such a common theme that what got lost in translation was the surprise! Boom. Babies are cheap! When I look back and what we were spending on our babies versus what we’re spending as they grow, there’s no comparison! As our kids age, they’re eating more, breaking more stuff (my 7yo kid just flooded our house), doing more with activities that cost a handsome amount, we’re driving them around more, paying for pre-school and now they have real hobbies! A common oversight I think new parents make (us included), is that somehow babies are expensive and then these kids become not-so-expensive as they age. Well, it only gets worse as they grow up (financially speaking of course!). Comparatively speaking, Babies are NOT expensive. Older kids ARE.

We Could Always Just Spend Less to Improve Our Budget – We spend a shitload of money each month. I’d say, “I don’t know where it goes”, but, well, I do. See, we charge everything for two primary reasons. First off, we exploit cash back credit cards (this Chase $200 Signup Bonus is currently the Best in Class for both rewards and cash bonus to start) to snag several hundred dollars per year in tax-free cash back in our pockets. I don’t toy with hotel points, airline miles and such, just cold hard cash. Secondarily, it’s a great way of tracking where every dollar goes. When you pay cash for everything (and your spouse does too), at the end of the month, it’s very difficult to figure out where the heck the money went. This month, when our credit card bill was enormous, I pored through the details and it made more sense – major car repair, my new iPhone, ski rental for the season and the tons my wife spends on food (I’ve flagged that as a major opportunity). That being said, I know where the money goes but we don’t really change our habits much. We’ve found it to be tough to say no, especially to life experiences. I’m all for not buying my kids crappy plastic toys and stuff they’re going to forget about in no time. However, when we’re invited out to dinner with some friends, a sitter a nice meal and drinks runs us like $150. We’ve enrolled our kids in everything from dance to soccer to weekends away with Adventure Guides. Each of these monthly fees exceed a hundred bucks. It really adds up and we’ve found it difficult to just put our foot down and say no. I mean, would we seriously tell our friends, “No, we don’t have the money so we’re not going out this month”, or tell the kids we can’t afford this season of soccer? It’s totally lame. The only reason I’ve been able to live this way without losing sleep over it is because I make enough on the revenue side to sustain it. But that doesn’t make it right. I’ll just say, for people who are really need of budget cuts (i.e. carrying credit card debt and/or increasing debt each month), cutting spending DOES really take a lifestyle change. It’s a lot tougher than it may seem! If I lost my job today or something else changes, we’d have to make some tough decisions.

Fortunately for us, while the prior 6 items were grossly miscalculated, I’ve been able to make up for it on the income side with blogging income, and expect some future dividends from my small business startup and real estate investment I’ve talked about elsewhere on the blog. I’ve had a lot of luck, opportunities and put in a lot of hard work to make these additional income streams work for me. Not everyone else has, so it’s understandable why so many people are struggling. Things just aren’t what they used to be, nor what they thought they would be.

I absolutely agree about the idea, “if I just make more later, i will be able to save more…” – if you are constantly waiting to save, you never will. I also use credit cards for 99% of my expenses for the same reasons.

Great post, Darwin. Our inflation is also going off the charts. We’re offsetting by producing more internally. Our own company cut loose with 2% raises this year, after two years of zero percent. Woo-hoo… 🙂

I really like this post also. Your candor is appreciated. I see a lot of myself in your words. Babies are incredibly inexpensive compared to older kids. Also, we spend a lot of money on those kids. It will be good when they are out of the house (LOL). Plus, they can take a dog or cat with them.

You are kidding about assuming a 6% annual return over the next 20 years, right? That implies a doubling period of 12 years, or just under 400% for the full 20 years. Just my personal view, but there aren’t enough cheap, accessible resources left in the world to generate that kind of return. Consider further that all economic growth for the past 30 years has been created by debt, to the extent we are now choking on the stuff (as well as all the pollution generated by that growth).
You’d probably do much better to invest your money in your home (is it secure, insulated, have off grid power of any kind, can you grow some of your own food) and community (community facilities, emergency preparedness) to try to ensure you and yours survive when the current system comes crashing down.

Well, I’ve conceded that equities will no longer provide the return they did in the past. 6% is considerably lower than the 8-10% historically. Furthermore, I invest broadly internationally, not just in the US. Additionally, if we expect high inflation, that isn’t necessarily bad for equities (since the shares are denominated in US dollars…dividends, profits, etc. will be artificially magnified thus boosting returns in dollar terms). Finally, I don’t live under the doomsday assumption; if it ever came to that, no matter what sort of preparations you think you’ve made, you’re doomed too. Just check out “The Road”. At some point, roaming hoards of hungry pirates would just come take your food, your home, whatever. If you have guns, you’ll be an even bigger target for them – they’ll get you one way or the other. So, we live under the presumption law and order will prevail.

I reckon before the full brakdown in law and order doomsday scenario comes to pass you will have to cope with:
Limited transportation (which will necessarily affect food deliveries)
Vastly increased energy bills, or even lack of energy itself
Decreased imports/availability of essential goods

All I am saying is make sure you ensure you can feed and keep your family warm and safe (as far as possible) before chasing your 6% returns. Money in the bank (or wherever) is no use to you if you have nothing to eat or no heating or hot water.

We can find better ways of using the existing resources. After all, there certainly isn’t enough wood in the world to support an economy that’s primarily fueled by burning wood. There aren’t enough animals to support a 7 billion population of hunter-gatherers. As technology advances, so does our use of resources.

I do agree that we will hit a wall if we continue to grow without at the same time increasing our efficiency or finding new sources.

The real danger is in stifling that process through bad laws, bad government, and corrupt politicians.

When I was a teenager, my dad showed me some equations about compound returns that stuck with me. I’ve been investing since 18, even in DRIPs. Always loved the idea. Unfortunately, stocks didn’t do what they were “supposed to do” over the past decade. But it’s better than having spent the money!

Wow. This post follows the reflective theme of my book. You took a hard look at the things that you have done, and currently do, to assess where you stand financially. Great post. The thing I like the best is the whole, kids are expensive. PERIOD. I have one, and am counting down the years until he his financially independent.

I think miscalculations are a part of the game, right? That’s why it’s best to revisit the plan often and correct course. The old joke that the plane to Hawaii is off course 99 percent of the time is true for financial plans also.

I froze up a little when I read your comment about the “new world.” While certainly things have changed, I don’t believe for a minute that the fundamentals of investing have forsaken us. People were peddling that in the late ’90s during the tech takeoff. I got sick of hearing about the “new economy” and “throw the old stuff out the window.” I was even fired by a client because he received a 48 percent return in a diversified portfolio with me while his friend got 76 percent with a tech-only portfolio.

I don’t think you were saying that the fundamentals are junk (in fact, different than another commenter, I like your six percent assumption). I just want to warn readers not to throw out the baby.

ON the baby: I have 16 year old twins. Not sure how my savings, budget and liver are going to handle college.

New economy to me applies more to expectations around jobs and the American standard of living. We’ve lived the past few decades on false prosperity by borrowing money we didn’t have and running up the debt.

Great article. I’m 34, have one 2 year old kid, and I’ve been working in public accouting for 10 years, and I’m just now starting to realize the truths of what you laid out so clearly above. It goes to show, even thoseof us who should know better tend to fall into the same popular assumptions (or should I call them myths?) as everyone else!

Great post! These are some great myths to bust. One thing I’ve read about is the “hedonistic treadmill” – basically your expenses will always try to match (or beat) any salary increases you make. My babies are expensive due to second rate insurance causing high medical bills and daycare bills. People told me that “baby stuff” would be expensive and it wasn’t. I think the “babies are expensive” myth is advertising to get people to buy large quantities of overpriced baby paraphernalia. Not buying into the advice to “buy expensive stuff now because I’d be making more later”, ie. house, car ect. was the best thing I ever did for my finances. Every year you can continue to drive the beater and put off buying a new car is a lot of money saved, and when you do buy the new car it will last one year longer. Which is the hedonistic treadmill again – it is much easier to delay that lifestyle improvement than it is to cut back later.

That was my mistake in the past — buying expensive stuff because I thought I would afford it later. That’s a lot of pressure, and you feel like you’re running faster just to stay in place. I much prefer freedom these days.